( Originally Published Early 1900's )
1. Essentially like domestic trade.—The study of international trade is likely to present difficulties unless at the outset one rids himself of certain wrong ideas which he is almost certain to have obtained from current newspapers and magazines as well as from conversations with untrained business men. For many centuries "practical" men have held such ideas as the following:
First, that foreign trade gives a strong and rich nation opportunity to exploit or take advantage of weaker nations.
Second, that in foreign trade the seller makes a profit and the buyer suffers loss, and where this view is entertained in any country a large volume of ex-ports is viewed with more pride than a large volume of imports.
Third, that a nation suffers real loss of wealth when it exports gold.
Fourth, that people who purchase goods made in foreign countries are doing two evil things; sending money out of the country and lessening the home demand for labor.
In this chapter it will be made clear that all ideas of this sort are erroneous. In its essence foreign trade is exactly like domestic trade. It possesses the same advantages and is governed by the same laws. It makes no difference whether a bale of Mississippi cotton is sold in Liverpool or in New York; the nature of the trade will be the same and the United States will be benefited by the one transaction no more than by the other. If the manufacturer of some article finds that his output is tending to outrun the demand, he may seek new outlets in foreign fields, or he may seek to enlarge the home demand by more intensive advertising in his own country. As a wise man he will adopt the policy that promises in the long run a steadier market and larger profits, and as far as the wealth and welfare of his country are concerned it will make no difference which policy he adopts. Trade between Pennsylvania and Kansas is a source of national wealth quite as much as trade between Pennsylvania and Europe. The people of each state, on account of the natural resources of their territory, possess advantages over the people of the other state in the production of certain commodities and by the medium of trade are able to share those advantages. Pennsylvania, for example, produces more iron and steel than its people can consume, while Kansas produces an excess of corn and wheat. Trade makes iron and steel products cheaper in Kansas and lowers the breakfast table cost in Philadelphia.
In exactly the same way foreign trade results in a benefit to both parties. England by its trade with the Orient gets tea and silk at reasonable prices, and the Orient in its turn gets the products of the skilled workmen in English factories.
Fundamentally, trade of all kinds arises out of the differences that exist among men and natural resources, especially the latter. Differences among men lead naturally to a division of labor, each 'man seeking more or less consciously that work for which he is best fitted. In the same way the people in any given territory produce those commodities for the production of which nature has given them the greatest relative advantage. So New England gives us apples and dairy products, the Dakotas specialize in wheat, Florida in oranges, California in fruit and cereals, the Southern states of the Union in tobacco and cotton. As a result of trade, the people of each state share in the advantages of all, benefitting quite as much by their purchases as by their sales.
Assuming that international trade is conducted as honorably as domestic trade—an assumption which is not strictly in accord with facts—the various peoples of the earth reap benefits and advantages from foreign trade in exactly the same way as do the people of the United States from the domestic trade within their own borders.
2. Prices and costs.—As we saw in our discussion of value, the prices of commodities tend to coincide with their cost of production, for if any article sells at a price much above cost the makers reap an unusual profit and additional competition is invited. More capital and more labor are drawn into the production of the article and the increased output which results tends naturally to cause a decline in price.
As between nations, however, competition of this sort is much less effective, mainly for the reason that labor cannot be persuaded to migrate from country to country as easily as from district to district in the same country. Furthermore, the resources, the ell-, mate and the industrial skill which enable a country to produce articles of such superior quality that they are favorites in the world's markets cannot be imitated by nations which desire to enter into competition with them. In the world's markets, that is in international trade, certain special products of such countries may command prices that yield to producers remarkable profits. For example, the wines, liquors and perfumes of France have been of such fine quality as to render competition on the part of other nations unsuccessful. If a French vintage sells much above its cost, its price can be lowered only by increased output in France itself. If Havana cigars sell at prices much above their cost, the fact will be due to Cuba's inimitable soil and climate. If capital and labor could move from the United States into Cuba as easily as they move from New York to Illinois, and the production of good Havana cigars be indefinitely increased, they could never be sold at prices that would yield their manufacturers more than an ordinary rate of profit.
3. International demand and supply.—The world's market prices of articles that figure in the imports and exports of nations are determined by the law of supply and demand. Let us take the case of wheat, a cereal produced in only a few countries but in demand all over the. globe. Where and how is its value or price determined? In the United States we think of the Chicago Board of Trade as the place where the bulls and bears fix the price of wheat, and it is doubtless true that more wheat is bought and sold in Chicago than in any other city of the world, and that fluctuations in Chicago prices are closely watched by. dealers in all countries. Yet the forces at work on the Chicago market are not local or national; the same forces are operating in Liverpool, in Buenos Ayres, in Hong Kong. They are the world-wide forces of supply and demand. What, is the visible supply of wheat in all the granaries of all countries? What are the crop prospects in the great wheat-growing countries north and south of the equator? Will the demand for wheat justify a price of $1.50 per bushel? Problems of this sort the speculator in wheat must solve, and he will not arrive at the right estimate of the value of wheat if his solution is erroneous.
4. So-called balance of trade.—In considering the foreign trade of a nation it is customary to take into account only the precious metals and other tangible commodities, such articles as are noted at the custom houses. At the present time, gold, since it is the world's money metal, is put in a class by itself and is popularly assumed to be imported or exported in settlement of a balance between exports and imports of merchandise. If a nation's imports have a value higher than that of its exports, its balance of trade is said to be unfavorable, and its balance is said to be favorable if the value of its exports exceeds the value of its imports. These expressions are likely to lead to misapprehension and therefore require some analysis.
5. Visible and invisible trade.—Strictly speaking, there is no such thing as a balance of trade between nations. Obviously economists have borrowed the word balance from accounting and not from physics. The balance is a shortage not an equilibrium. For a year or a period of years, the value of the imports of commodities as compared with the exports, or vice versa, may show such a balance or shortage; yet in the long run one must equal and offset the other and pro-duce an equilibrium. And even the temporary difference between the two could not exist were it not that nations indulge in credit transactions just as do individuals.
Between 1850 and 1880 European investors made large advances to the builders of American railroads, besides purchasing interests in lands, forests and mines. As evidence of their investment they received stocks and bonds. This European capital increased the buying power of the United States and brought about larger imports of goods from foreign countries. Toward the end of the century the payment of interest and dividends to the European investors reversed the situation and caused an increase of exports from the United States as compared with the imports. The great war in Europe (1914-1918) increased the excess of exports and new elements came to the front. The people of the United States, acting either as individuals or thru their Government, bought back from the Europeans the American securities which they had held for so many years and in addition loaned them upwards of eight billion dollars. These transactions, invisible so far as the statistics of foreign trade are concerned, account for the great excess of merchandise exported from the United States during the four years of the war. Movements of securities between nations are of great importance. The foreign trade of no nation can be understood unless these movements are taken into account.
Other invisible items influence the foreign trade of nations in greater or less degree. Before the war, for instance, Americans were fond of European travel and were notorious money spenders. To a student of foreign trade they were all importers; altho instead of sitting at home and ordering foreign goods sent to them, they went abroad and bought the goods them-selves, consuming most of them on the spot. In payment for the goods bought by American tourists the United States was obliged to export goods in excess of those imported through the custom houses.
6. Fundamental propositions.—The conclusions in the preceding section will not be perfectly clear to the reader until he thoroly understands how inter-national payments are effected, and this is a difficult subject to which a whole volume in the Modern Business Course has been devoted, namely, Volume 17, "Domestic and Foreign Exchange." Here we will call the reader's attention merely to three fundamental propositions which are not difficult of comprehension.
First, a nation cannot pay for all of its imports with gold. In normal times every nation nearly always has all the gold it desires or requires. If a nation sought to pay its foreign indebtedness with gold, the lessening of its stock would tend to cause prices to fall and so automatically make it a good market for buyers from other countries and thus lead to an in-crease in its exports of merchandise.
Second, gold, like any other commodity, tends to flow towards those countries where its value is high-est. This means that gold naturally seeks those countries were prices are lowest. If, therefore, any country is suffering from abnormally low prices, whatever the reason, some portion of the world's gold is drawn to it and its exports are increased accordingly.
Third, in the long run the exports of merchandise from any country must equal its imports. Any difference or so-called balance in any year must be offset by invisible items, such as securities and credit extensions between banks. These credits in the course of time must be liquidated by the shipment of goods.
7. International payments.—Payment for goods bought in foreign countries are effected thru the agencies of banks and so-called bills of exchange, the method being essentially the same as that followed within a country when debtor and creditor live in different cities.
The American exporter of wheat makes a draft upon the consignee for the amount due him and gives his draft to his local bank for collection. As drafts on London are acceptable the world over, just as drafts on New York are acceptable at par anywhere in the United States, we will assume that the draft is in pounds sterling, one sovereign being equivalent to $4.86 2/3. The American banker will forward the draft with bill of lading and insurance policy to his correspondent in London, who will present it for acceptance to the consignee and credit the American banker with its present worth.
By such transactions the American banker keeps a balance to his credit with his London correspondent and is able to sell drafts on London to any of his customers who wish to make remittance to Europe.
Thus exports create the supply of foreign ex-change, that is, they build up the balances that stand to the credit of a country's banks. Imports constitute the demand for foreign exchange. If at any time the demand exceeds the supply so that the foreign balances of the banks of a country become abnormally low, then either gold must be exported or a credit balance be built up by the shipment of securities.
If gold is exported beyond a certain amount, the market prices of some commodities will sag and an increase in the exports of such commodities will en-sue, thus obviating the necessity for further gold ex-ports.
8. Favorable balance fallacy: The fact that the nature of foreign trade is not generally understood is shown by the survival and common use of the expression "favorable balance of trade" in connection with the difference between merchandise exports and imports. The phrase is several centuries old, having been coined in the days of the Mercantilists, who believed that foreign trade was advantageous only insofar as it caused an inflow of the precious metals. Large exports and relatively small imports were thought desirable, for then a balance existed which had to be paid in gold and silver.
It must be evident to the reader that it is utterly illogical to speak of any balance of trade as being favor-able to a nation. The difference between a country's exports and imports of tangible goods is only an apparent balance, for it is always offset by invisible items which do not appear in the statistics of trade.
The trade of England and the United States before the European war furnished excellent illustrations of the conditions which bring into existence a so-called balance of trade. The people of England had large investments in foreign countries on which the interest and dividends amounted to many hundred million pounds. The English investors received their interest or dividends in the form of drafts or bills of ex-change, payable in gold at English banks, but the countries from which these drafts came did not send gold to London to provide means of payment. That would have been impossible, for many of England's investments were in countries which possessed very little gold, their money being either paper or silver. Furthermore, it was not necessary to send gold. Commodities possessing equal value were shipped in-stead and bills of exchange representing the value of these commodities found their way into London banks in a volume sufficient to provide a fund for the payment of the interest and dividends due Englishmen on their foreign investments.
Thus it happened that for many years England's imports of merchandise were largely in excess of her exports. The Mercantilists would have called this an unfavorable balance. Yet it is evident that the words "favorable" and "unfavorable" possess no significance whatever in connection with the facts. The statistics of England's trade showed merely that she was a creditor nation.
The United States, on the other hand, for fifty years before the European war was a debtor nation. Foreigners had invested heavily in its various enterprises and were receiving large sums in the payment of interest and dividends. Furthermore, the overseas' trade of the United States was carried in foreign bottoms and the freight charges, amounting to over one hundred million dollars annually, were paid to foreigners. These and other invisible items of trade, together with the imports of merchandise, constituted a demand for foreign exchange offsetting the supply created by the exports. Naturally, therefore, the exports of merchandise from the United States were largely in excess of the imports. The American newspapers, when publishing the annual statistics of their country's foreign trade, never failed to refer with pride to the huge excess of exports as if it somehow indicated great prosperity. Yet of the conditions which caused the existence of that excess some were regrettable, as, for example, our dependence upon foreign shipping, and none could be regarded as a matter for pride unless a nation has a right to be proud when given evidence that it is paying its debts.
We might conclude this section by certain general propositions each of which is a corollary flowing from the preceding discussion.
First, when a country is borrowing capital from foreigners its imports of goods will tend to exceed its exports.
Second, when the people of a country begin to in-vest capital in foreign countries the exports of that country making the investments will for a time tend to exceed the imports.
Third, when the people of a country have large in-vestments in foreign countries on which interest and dividends are paid, the imports of that country will tend to exceed the exports.
9. The surplus fallacy.—We must briefly consider the common idea that the chief advantage of foreign trade lies in the fact that it enables a country to get rid of its "surplus'' products. It is assumed that America produces a surplus of wheat and cotton, that England produces a surplus of manufactures, France a surplus of wines, India a surplus of tea, and so on, and that foreign trade must be encouraged in order that these various surpluses may be profitably disposed of.
The use of the word "surplus" in this connection gives the unthinking man an entirely erroneous impression, for it gets the cart before the horse. It implies that foreign trade is a device to get rid of a surplus product, whereas the so-called "surplus" was brought into existence because of the demand created by foreign trade.
Let us imagine, if possible, that the United States was absolutely cut off from the rest of the world and that, therefore, it had no foreign trade. Evidently then our farmers would produce only as much wheat as they could sell at a satisfactory price to their own countrymen. Except as they erred now and then in their estimates of the home demand, there would never be any surplus.
As a matter of fact the so-called surplus of America's products, which is exported to foreigners, constitutes merely that portion of its products which foreigners will buy at higher prices than Americans are willing to pay. Normally no producer will take the trouble to ship goods abroad unless he feels certain that he can get better prices abroad than he can 'at home. Wheat and cotton, like all other commodities,
including gold, seek the markets paying the highest prices. The export of a commodity is always evidence that the home market will absorb no more of it at the price that foreigners are willing to pay. Any talk about a surplus which must be exported is illogical and unscientific.
10. Volume of a country's foreign trade.—In every country business men take much more interest in the exports than in the imports of merchandise. Measures and plans for the enlargement of exports, for the opening up of new markets for the country's products, constitute a perennial topic for editorial discussion in the newspapers and always have the lively support of commercial bodies and governments. This is the natural point of view of the mercantile community, intent upon securing customers for its goods. That in return one nation must buy the products of other nations they are well aware, but they do not consider it their province to push such purchases. On the other hand, this appears to them to be distinctly the problem of the other nations and one which can be properly left to them.
The general public too often misses this point of view and invests exports with a peculiar virtue. The public apparently assumes that the world's markets, if they are only properly studied and exploited, can be made to absorb an unlimited quantity of any country's produce. To the other side of the subject, namely, imports, very little thought is given. Yet it must be evident that no country can sell largely to foreigners unless it in turn buys largely, for in the long run the imports must offset the exports.
In the last analysis, therefore, the volume of a country's foreign trade depends upon the desire of its people for foreign goods quite as much as upon their ability to produce goods which foreigners are anxious to buy. Practically it is wise for the business men of any country to use every effort to open up new markets, whether at home or abroad, but it is unwise at the same time to seek to prejudice people against the consumption of foreign goods. People vaguely think of foreign trade as a sort of fight between nations, those who sell the most and in the greatest number of markets being looked upon as victorious, while the others are regarded as having been beaten in trade. After the close of the world war there was much talk of this sort in Europe as well as in America. One heard and read much about the- inevitable economic warfare that was to ensue and the inevitable bitterness that would follow. All talk of this sort is irrational and unjustifiable, and underlying it is the fallacious notion that trade is a one-sided affair, that nations can sell more without buying more.
The United States is a big country possessing a great variety of resources. Minnesota and Pennsylvania both have iron mines and are competitors in all markets, but the people of those two states are not embittered toward one another. California and Florida, both fruit growers, are friendly rivals, each realizing that it must deserve its markets if it is to retain them. The nations which crushed the demon of militarism in Germany are now struggling to regain the markets which were lost during the war. The success of any one should not cause bitterness or resentment among the others. It should rather spur the others to render their methods of production and distribution more efficient and to increase their understanding of the needs and tastes of the various peoples whose friendly patronage they desire.
11. International finance.—Must a country establish banking facilities abroad before it can build up a large foreign trade? This question suggests the old conundrum "which came first, the chicken or the egg?" In each case all we can say is that the two are interdependent. 'Without the egg there would be no chicken, and without the aid of banks trade can make little progress.
For over two centuries London has been the financial centre of the world and a sterling bill, redeemable in gold in London, has served as a sort of world money acceptable everywhere as the equivalent of gold. England's financial prestige is the direct outgrowth of her enterprise and liberal commercial policy. The Union Jack, protected by the British Navy, is a familiar ensign in every commercial port. In every market can be found men who are buyers of English goods or of goods transported in British bottoms, and also men who are exporting their native products to the English markets or to other foreign markets thru the medium of English merchants.
It is this vast and varied trade of the United Kingdom that has made the sterling bill, as a draft on London is called, an acceptable means of payment between business men in all parts of the world. The fact that before the outbreak of the war in Europe a sterling bill was always redeemable in gold in Lon-don undoubtedly gave London some financial prestige, but that fact alone could not have made London the world's financial centre. The commanding position of that city is due, not mainly to its wealth nor to its sound financial policy, but to the world-wide trade which its merchants and merchant marines have fostered.
If the foreign trade of the United States is to develop normally, its banks must have branches and other trusted representatives in foreign countries. In this way proper credit relations can be established and convenient means of payment be created.
1. When is a "favorable" balance of trade said to exist? Ex-plain what is meant when it is said that actually there is no such thing as "balance of trade."
2. What is meant by "visible" and "invisible" exports and imports?
3. Explain why the investment of large sums of money in foreign countries by the people of one country at first produces an excess of exports over imports in that country to be followed later by an excess of imports over exports.
4. Why must a country establish banking facilities abroad be-fore it can build up a large foreign trade?